Deck 21: Mergers and Acquisitions

Question 1

In practice, most acquirers pay a substantial acquisition premium, which is the percentage difference between the acquisition price and the premerger price of the target firm.

Answer 1

True

Question 2

Savings that come from combining the marketing and distribution of different types of related products is/are called

A)vertical integration.
B)economies of scale.
C)horizontal integration.
D)economies of scope.

Answer 2

economies of scope.

Question 3

The 1990s era was known for 'strategic' or 'global' deals that were more likely to be friendly and to involve companies in related businesses; these mergers often were designed to create strong firms on a scale that would allow them to compete globally.

Answer 3

True

Question 4

Consider two firms, Thither and Yon. Both companies will either make $30 million or lose $10 million every year with equal probability. The companies' profits are perfectly negatively correlated. What are the expected after-tax profits of Thither in any year, assuming a corporate tax rate of 30% and no tax loss carryforward?

A)$21 million
B)-$5.5 million
C)$5.5 million
D)$7 million

Question 5

Which of the following statements regarding 'vertical integration' is FALSE?

A)A company might not be happy with how its products are being distributed, so it might decide to take control of its distribution channels.
B)Vertically integrated companies may be large, but unlike other large corporations, since they remain focused in one industry they are easy to run.
C)The principal benefit of vertical integration is coordination. By putting two companies under central control, management can ensure that both companies work toward a common goal.
D)A company might conclude that it can enhance its product if it has direct control of the inputs required to make the product.

Question 6

Consider two firms, Thither and Yon. Both companies will either make $30 million or lose $10 million every year with equal probability. The companies' profits are perfectly negatively correlated. What are the expected after-tax profits of the combined company (Thither and Yon)in any year, assuming a corporate tax rate of 30% and no tax loss carryforward?

A)-$5.5 million
B)$21 million
C)$7 million
D)$5.5 million

Question 7

Which of the following statements regarding 'efficiency gains' is FALSE?

A)Although identifying poorly performing corporations is relatively easy, fixing them is another matter entirely.
B)A chief executive of an inefficiently run corporation can be ousted by current shareholders voting to replace the board of directors, and in fact many ineffective managers are replaced in this way.
C)A justification that acquirers cite for paying a premium for a target is efficiency gains, which are often achieved through an elimination of duplication.
D)Takeovers relying on the improvement of target management are difficult to complete, and post-takeover resistance to change can be great. Thus not all inefficiently run organisations are necessarily more efficient following a takeover.

Question 8

The fact that a large company can enjoy savings from producing goods in high volume that are not available to a small company is called

A)economies of scope.
B)economies of scale.
C)vertical integration.
D)horizontal integration.

Question 9

The 1990s era was known for hostile, 'bust-up' takeovers, in which the acquirer purchased a poorly-performing conglomerate and sold off its individual business units for more than the purchase price.

Question 10

Which of the following statements regarding 'monopoly mergers' is FALSE?

A)Society as a whole bears the cost of monopoly strategies, so most countries have antitrust laws that limit such activity.
B)It is often argued that merging with or acquiring a major rival enables a firm to substantially reduce competition within the industry and thereby increase profits.
C)Financial researchers have found that the share prices of other firms in the same industry did not significantly increase following the announcement of a merger within the industry.
D)While only the merging company benefits when competition is reduced, all companies in an industry pay the associated costs.

Question 11

The justification for the benefits of diversification from mergers include all of the following EXCEPT:

A)liquidity enhancement
B)tax loss benefits
C)lower cost of debt or increased debt capacity
D)direct risk reduction

Question 12

On average, when a bid is announced, the share price of the target rises.

Question 13

Consider two firms, Bob Company and Cat Enterprises, both with earnings of $10 per share and 5 million shares outstanding. Cat is a mature company with few growth opportunities and a stock price of $25 per share. Bob is a new firm with much higher growth opportunities and a share price of $40 per share. Assume Bob acquires Cat using its own shares and the takeover adds no value. In a perfect capital market, how many shares must Bob offer Cat's shareholders in exchange for their shares?

A)0.625 shares of BobCat company for each share of Cat Enterprises
B)1 share of BobCat for each share of Cat Enterprises
C)0.3846 shares of BobCat company for each share of Cat Enterprises
D)1.6 shares of BobCat company for each share of Cat Enterprises

Question 14

Merger activity is greater during economic contractions than during expansions.

Question 15

Which of the following statements regarding mergers and diversification is FALSE?

A)Like a large portfolio, large firms bear less idiosyncratic risk, so often mergers are justified on the basis that the combined firm is less risky.
B)Because it may be easier to measure performance accurately in a conglomerate, agency costs may be reduced and resources may be more efficiently allocated.
C)Because most shareholders will already be holding a well-diversified portfolio, they get no further benefit from the firm diversifying through acquisition.
D)Because employees are obligated to hold idiosyncratic risk, they benefit when the firm reduces that risk by conglomerating.

Question 16

The 1980s era was known as the 'conglomerate wave' because firms typically acquired firms in unrelated businesses.

Question 17

Most acquirers pay an acquisition premium for a target. Upon announcement of the bid, the target's share price increases, on average, so that the share price is the same as the price bid by the acquirer.

Question 18

The merger of two companies in the same industry that makes products required at different stages of the production cycle is called

A)economies of scope.
B)economies of scale.
C)vertical integration.
D)horizontal integration.

Question 19

The synergies of a merger add so much value to the combined firm that, upon announcement of a merger, the share prices of both the target and the acquirer increase substantially.

Question 20

Which of the following statements is FALSE?

A)Diversification benefits are by far the most common justification that bidders give for the premium they pay for a target.
B)Chief among the costs associated with size is that larger firms are more difficult to manage.
C)An acquirer might be able to add economic value, as a result of an acquisition, that an individual investor cannot add.
D)For most investors, an investment in the share market is a zero-NPV investment.

Question 21

Consider the following equation: The term T in this equation refers to

A)the pre-merger (standalone)value of the target.
B)new shares to pay for the target.
C)the pre-merger, or standalone, value of the acquirer.
D)the value of the synergies created by the merger.

Question 22

Any acquirer shares received in full or partial exchange for target shares triggers an immediate tax liability for target shareholders.

Question 23

Consider the following equation: The term S in this equation refers to

A)the value of the synergies created by the merger.
B)new shares to pay for the target.
C)the pre-merger, or standalone, value of the acquirer.
D)the pre-merger (standalone)value of the target.

Question 24

When a hostile takeover appears to be inevitable, a target company will sometimes look for another, friendlier company to acquire it called a

A)classified board.
B)golden parachute.
C)white knight.
D)poison pill.

Question 25

For a hostile takeover to succeed, the acquirer must appeal to the target shareholders; this is usually done through

A)a white knight and a proxy fight.
B)a staggered board and a white knight.
C)a tender offer and a proxy fight.
D)a tender offer and a poison pill.

Question 26

Which of the following statements regarding 'poison pills' is FALSE?

A)Poison pills also increase the bargaining power of the target firm when negotiating with the acquirer because poison pills make it difficult to complete the takeover without the cooperation of the target board.
B)Companies with poison pills are harder to take over, and when they are taken over, the premium that existing shareholders receive for their shares is higher.
C)Because a poison pill increases the cost of a takeover, all else equal, a target company must be in better shape to justify the expense of waging a takeover battle.
D)By adopting a poison pill, a company effectively entrenches its management by making it much more difficult for shareholders to replace bad managers, thereby potentially destroying value.

Question 27

A situation where every director serves a three-year term and the terms are staggered so that only one-third of the directors are up for election each year is called a

A)poison pill.
B)golden parachute.
C)white knight.
D)classified board.

Question 28

A 'golden parachute' is an extremely lucrative severance package that is guaranteed to a firm's senior managers in the event that the firm is taken over and the managers are let go.

Question 29

Which of the following statements regarding recapitalisation as a takeover defence is FALSE?

A)Restructuring itself can produce efficiency gains, often removing the principal motivation for the takeover in the first place.
B)In many cases, a substantial portion of the synergy gains that an acquirer anticipates from a takeover are savings from a decrease in leverage as well as other cost reductions.
C)Another defence against a takeover is a recapitalisation, in which a company changes its capital structure to make itself less attractive as a target.
D)By increasing leverage on its own, the target firm can reap the benefit of the interest tax shields.

Question 30

Assume that Martin pays no premium to acquire Luther. Calculate Martin's price-earnings (P/E)ratio both pre- and post-merger. Show your calculations.
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Question 31

A rights offering that gives existing target shareholders the right to buy shares in either the target or the acquirer at a deeply discounted price once certain conditions are met is called a

A)golden parachute.
B)white knight.
C)poison pill.
D)classified board.

Question 32

What is a 'white knight'?
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Question 33

Consider a case in which existing shareholders do not have to invest time and effort, but still participate in the gains from a takeover, while the bidder who puts in the time and effort is forced to give up substantial profits. This situation is called

A)a leveraged buyout.
B)a golden parachute.
C)the free rider problem.
D)a toehold.

Question 34

Which of the following statements is FALSE?

A)Once the acquirer has completed the valuation process, it is in the position to make a tender offer - that is, a public announcement of its intention to purchase a large block of shares for a specified price.
B)A stock-swap merger is a positive-NPV investment for the acquiring shareholders if the share price of the merged firm (the acquirer's share price after the takeover)exceeds the pre-merger price of the acquiring firm.
C)Purchasing a corporation usually constitutes a very large capital investment decision, so it requires a more accurate estimate of value that includes careful analysis of both operational aspects of the firm and the ultimate cash flows the deal will generate.
D)If we view the pre-bid market capitalisation as the standalone value of the target, then from the bidder's perspective, the takeover is a positive-NPV project only if the synergies created do not exceed the premium it pays.

Question 35

If Martin pays no premium to acquire Luther, what will the earnings per share be after the merger? Show your calculations.
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Question 36

Once a tender offer is announced, the uncertainty about whether the takeover will succeed reduces the volatility of the share price. This uncertainty creates an opportunity for investors to speculate on the outcome of the deal without bearing the risk of volatility.

Question 37

Consider the following equation: The term x in this equation refers to

A)the pre-merger, or standalone, value of the acquirer.
B)new shares to pay for the target.
C)the pre-merger (standalone)value of the target.
D)the value of the synergies created by the merger.

Question 38

Which of the following statements is FALSE?

A)The method of payment (cash or shares)affects how the value of the target's assets is recorded for tax purposes and it affects the combined firm's financial statements for financial reporting.
B)Any goodwill created in a merger deal can be amortised for tax purposes over 15 years.
C)The combined firm must mark-up the value assigned to the target's assets on the financial statements by allocating the purchase price to target assets according to their fair market value.
D)Many transactions are carried out as acquisitive reorganisations under the tax law. These structures allow the target shareholders to defer their tax liability on the part of the payment made in acquirer shares but they do not allow the acquirer to step up the book value of the target assets.

Question 39

Consider the following equation: The term A in this equation refers to

A)the value of the synergies created by the merger.
B)new shares to pay for the target.
C)the pre-merger (standalone)value of the target.
D)the pre-merger, or standalone, value of the acquirer.

Question 40

KT corporation has announced plans to acquire MJ corporation. KT is trading for $45 per share and MJ is trading for $25 per share, with a pre-merger value for MJ of $3 billion dollars. If the projected synergies from the merger are $750 million, what is the maximum exchange ratio that KT could offer in a share swap and still generate a positive NPV?

Question 41

Mayo Corporation is currently trading at $30 per share. There are 10 million shares outstanding, and the company has no debt. You believe that the value of the company would increase by 50% if the management team was replaced. How much would you need to offer in total to acquire 50% of Mayo's shares?

A)$300 million
B)$10 million
C)$150 million
D)$100 million

Question 42

You work for a levered buyout firm and are evaluating a potential buyout of Boogle Inc. Boogle's share price is $18, and it has 3 million shares outstanding. You believe that if you buy the company and replace its dismal management team, its value will increase by 50%. You are planning on doing a levered buyout of Boogle and will offer $25 per share for control of the company. Assuming you get 50% control, what will your gain from the transaction be? Show your calculations.
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Question 43

Mayo Corporation is currently trading at $30 per share. There are 10 million shares outstanding, and the company has no debt. You believe that the value of the company would increase by 50% if the management team was replaced. How much would you gain from acquiring 50% of Mayo's shares by borrowing, attaching the debt to the company and replacing management?

A)$300 million
B)$10 million
C)$150 million
D)$225 million